Painful lessons from nailing a market bottom

I’ve got two stories full of lessons my hedge fund days that I’ve shared from TradingWithCody.com here on my Marketwatch blog. Both are about markets collapsing, but each has a very different perspective. The second one is below. Click here for yesterday’s piece.

I’d just raised my first institutional funds, almost doubling the size of my hedge fund and (hopefully) opening the doors to other institutional money placers like foundations and fund-of-funds managers and so on. Having started my tech-centric hedge fund in the months leading up to a final bottom at 75% from the top in the Nasdaq was a great move both investment-wise and for me for the long-term. However, it made raising money for this cowboy from Ruidoso who’d graduated from UNM (not Harvard) and had been a salesman/analyst at a small shop in Oppenheimer (not a hot shot trader at Goldman) — well, it made raising money hard. So I was obviously thrilled when I’d gotten a wire from a fund-of-funds manager in late February 2003.

The markets had been fading and falling as rumors and news and all indicators were that the U.S. was going back into Iraq to get Saddam Hussein, whether he was affiliated with 9/11 and/or Al Queda or not. I’d been heavy in cash to start the year as I was still just months into my new hedge fund launch and I was trading very conservatively with the funds I had raised, some of which came from my old child hood best friend, Neil Patrick Harris (whose wonderful family, including his parents, was featured on Oprah Next Chapter on Monday night by the way). So I was up a little bit vs. a down overall stock market when that money arrived in early March 2003. I’d done my homework on history and had seen that into almost every invasion/start of war in the history of the US, that the markets would fall and then almost immediately bottom when the actual invasion/war started. I wanted to be long and strong into the actual event, but I didn’t want to be too early, of course.

Here’s a chart of the Nasdaq fading into the actual Iraq invasion:

So I immediately started putting that money to work when it arrived in late February, right at the top of that chart above, and as the markets continued to fall, I continued to scale into more of my longs like Amazon AMZN Microsoft MSFT and Cisco CSCO and to cover up my shorts which included Research in Motion RIMM at the time as I recall. By the time I came into work on March 13, 2003, I’d seen my year go from up single digits to down nearly double digits over the past month. My phone was ringing when I walked into my hedge fund hotel office I’d rented at near-charity rates from my prime broker on the 40th floor of a high rise in midtown Manhattan.

It was the guy from the fund-of-funds on the phone. He was screaming at me before I could say, “hello”.

“Where the #$%&@ have you been? It’s 6:15am and the limits are locked lower and the markets are going to crash this morning!” he yelled hoarsely into the phone. “I’ve left you fifteen @*#%$ messages already and you’re just now lollygagging in?!” Well, that explained his raspy voice. I wondered how many messages he’d left other managers this morning too. Before I could finish the thought, he continued berating me,”You @(*# idiot, you told me not to worry and that we could trust you to get longer! We told you not to cover your shorts, I told you not to buy nothing! I knew better than to put our money with an active manager. I want to know what you’re going to do this morning and I want to know when I can get my @*(&# back out of your #@(*&@# fund!”

I took an extra split second before answering, to make sure he really was going to let me speak, and I told him, “Well, as for what I’m going to do this morning, I’m planning to stick with my playbook which says to buy the markets as we head into an invasion/war and I’m going to cover some more shorts to get even longer.” He tried to interrupt me, but I continued, “You’ve got a one year lock in on the capital you put in my hedge fund, but I’ll be happy to get it back to you as soon as the markets bounce so I won’t have to sell into this textbook collapse.” And I hung up the phone as he started yelling again.

I did what I said I was going to do, though I’ll certainly admit that I was scared out of my mind and that the buys and short covering I did that morning were some of the hardest trades I’ve ever done. By the time the markets opened and my 99-limit voicemail box had gracefully cut off the barrage of digital abuse that awaited me from that fund-of-fundser who was surely yelling in whispers by now, I was down an immediate 5% more than I’d been the day before. I covered my last short and bought calls in GE and I wrote about how doing so was the hardest trade I’d ever made for my subscribers of my trading diary which was at TheStreet’s RealMoney.com at the time. I told them I’d never seen such overwhelming bearishness and while I didn’t think that in and of itself would mean that we would put in an immediate bottom, I did believe that following the playbook was the only way to trade, especially when the playbook was indeed playing out so according to plan.

When I finished writing that post, I grabbed my waste basket and threw up. Running a hedge fund (not to mention doing a live business TV show from a bar for Fox) was horrible for my nerves and my stomach. And I went on a walk. There was nothing else I could do at that point. I figured my money management career was probably over. What would I do for a living, man? I’d been on TV a couple times, but it wasn’t like I’d been “discovered” by a CAA agent at that point, much less did I have but a handful of contacts in the media world. Could I go back to working at a tech or telecom corporation as I’d done for a while in 2000 and 2001? Ugh, corporatocracy. And what would I tell my parents? Oh, man, they’d even put their first money in the stock market with me.

The self-doubts had started ricocheting around my skull and my temples were pounding as I realized I was standing in the basketball courts in the projects across the street from my first apartment in NYC at 101st and Amsterdam. I knew a couple of the guys playing in the pick up game and they hollered over at me, recognizing me even in my dress shirt and jeans.

“So you going to war now that it’s started?” they asked me. And that’s how I found out that the U.S. had in fact headed into Iraq. “Any idea what the markets are doing?” I asked everybody standing around us (this was before smartphones) and somebody said, “Yeah, man, they’re skyrocketing.”

I caught a cab back to my office and sure enough, every stock on my screen was green. Most were up 3%-5% and some of my biggest positions, including those in which I owned call options, were up 10% or more. I had gone from being down 5% on the day and nearly 15% on the year, to being up 16% on the day and back up single digits for the year. The fund-of-funds who had just put their money into my hedge fund were now up nearly 10% since they’d sent in the money. My phone on my desk was ringing.

I answered it and heard the fund-of-fundser on the other line — to his credit, apologizing. “Man, what a ride, Cody. Sorry for the way I handled all of that.”

No problem I told him and I continued, “As I’d said earlier, I’ll have your money back to you when I wouldn’t be selling into a panic. With this pop, I think you’ll have your money within the next week or so.”

He told me he didn’t want his money back. In fact, maybe they should be putting a little more into my actively managed approach he wondered aloud.

But I’d had enough of the problems that come with institutional money. I’d now seen firsthand how emotions would kill my performance and all I knew is that neither Neil nor any other of my investors besides this money manager dude who had “blessed me” with his money, had freaked out when the going got tough. Managing money is hard enough without the crazies that come from taking institutional money. In the years that followed, I often wrote even in the Financial Times about how I’d made the conscious choice to forego the size that could have come by becoming a pigeon-holed tech fund that would easily be able to play the institutional money game in the name of seeking outright performance for the investors who trusted me with their money.

Here’s what the markets did after bottoming exactly on March 13, 2003:

Certainly I made a lot of mistakes before and after that wild ride in March 2003, but I’ll never forget the lessons I learned in that particular market bottom that I happened to have nailed, even as I had to suffer through all that pain to get there.

Cody Willard writes Revolution Investing for MarketWatch and posts the trades from his personal account at TradingWithCody.com. At time of publication, Cody was net long Apple, Google, Lindsay, Juniper and Cisco.

Story Conversation

About The Cody Word

Cody Willard writes the Revolution Investing investment newsletter for MarketWatch and posts the trades from his personal account at TradingWithCody.com He is the founder of WallStreetAll-Stars.com and the principal of CL Willard Capital. Cody serves as an adjunct professor at Seton Hall University and is on the University of New Mexico Alumni Board. He was an anchor on the Fox Business Network, where he was the co-host of the long-time #1-rated show on the network, Fox Business Happy Hour. Cody, a former hedge fund manager, and his stock picks and economic outlooks have been featured on NBC’s The Tonight Show with Jay Leno, ABC’s 20/20, CBS Evening News, CNBC’s SquawkBox, Jon Stewart’s The Daily Show, as well as in the Financial Times, Wall Street Journal, New York Times, and many other outlets.